The sharp corrections in the freight markets following the well-publicised credit crisis and its effect on trade finance have placed a number of charterers under financial stress, with some having gone into administration as a result. A number of charterers in long term time charters and shippers in contracts of affreightment now find themselves in uneconomical bargains and are, perhaps understandably, looking to renegotiate terms or to walk away from their contracts. This article will consider the extent to which the doctrine of frustration is relevant in this context.
The majority of precedents suggest that, the maritime adventure being commercial in nature, the contracting parties anticipate making profits and losses from the contracts into which they enter; whether the loss is greater than initially anticipated does not negate the fact it is nonetheless contemplated - such losses are business risks and cannot amount to a legally frustrating event.
However, the recent market conditions have been unique. In reviewing the case law on frustration the article will look at whether certain contracts, which contemplate a specific trade, could arguably be discharged because post-formation events have occurred that make the originally contemplated performance effectively impossible.
In the first half of 2008 freight markets and the commodity markets’ shipping services were particularly lucrative with many charterers and owners making huge profits. The extent of the correction in the markets has compelled some operators to repudiate or renegotiate their contracts in order to survive. An interesting and much employed argument is to claim the contract has been frustrated, but is such an argument meritorious and is it likely to be successful?
A contract may be legally frustrated (or discharged) if, after its formation, events occur making its performance impossible or illegal: “the parties must from the beginning have known that unless…some particular specified thing continued to exist”[1] the contract would be discharged. Could that “specified thing” be the availability of trade credit - notably letter of credit (“L/C”) facilities?
L/Cs are the most common method of financing international trade transactions but banks are currently refusing to open them due to credit concerns. Consequently, buyers are unable to arrange for advance L/Cs; many reports suggest that as much as 70% - 100% of the finance must be paid in advance for the bank to agree to open the L/C.
As a result a buyer may be unable to pay the seller (who may also be the shipper of the goods and charterer of the vessel upon which goods are being carried) through the agreed method of finance - often an express term in the sale of goods contract.
It is an implied condition in any contract subject to English law that the parties will be excused before breach where performance becomes impossible due to the perishing of a specific thing, without the fault of the contractor.
The doctrine of frustration was extended further in the early 1900s to include cases where performance was impossible otherwise than through the perishing of a specific thing i.e. where performance was not impossible but the commercial object, or purpose, of the contract was frustrated.[2]
In Krell v Henry the defendant hired a flat in Pall Mall for the days on which the procession planned for the coronation of King Edward VII were to take place. His object was to see the procession, though this was not expressly stated in the contract. The contracted was held frustrated when the procession was postponed because of the illness of the King. Even though performance was not physically impossible as the defendant could have used and paid for the flat on the days in question, in the court’s opinion the defendant would have suffered “unacceptable hardship” if he had been held to the contract in the altered circumstances.
It would appear that in light of the above rationale there is an arguable case to suggest that where the L/C cannot be arranged the contract is frustrated. The difficulty with such an argument is that, as mentioned above, the L/C can be opened by putting up a substantial proportion of the amount contract price (70-100%), thus rendering performance “possible”- with the effect that the obligation to perform under the contract is arguably still live and not discharged.
It is worth noting that the courts have refused to extend the doctrine of frustration to include extreme hardship because this may enable a party to claim relief merely because the circumstances had changed to such an extent as to turn the contract, for him, in to a very bad bargain.
In British Movietonews[3] Viscount Simon summarised the English law position of frustration as follows:
“The parties to an executory contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate - a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to the execution, or the like. Yet this does not in itself affect the bargain which they have made.”
Taking into account the current fluctuations in charter rates, the question which arises is, where, say, a charterer faces bankruptcy, can the change in circumstances render the contract more than just “a very bad bargain” falling within the doctrine of frustration or are those charterers compelled to honour their obligations at the expense of their solvency?
The reluctance of banks to issue credit has resulted in a dramatic drop in trade. Consequently, hire rates have also dropped dramatically because charterers and owners are finding it difficult to keep vessels in employment. The factual scenario upon which the fixture was made, namely the existence of an underlying commodity trading pattern has changed. Would this have been a foreseeable risk when entering in to a charter party?
Charterers who entered into long term time charters providing for daily rates as high as US$80,000 - 90,000, when the equivalent rate is now around US$8,000, would strongly argue that this was not a foreseen eventuality. The commercial value of this contract, from the charterer’s perspective, has been undermined.
The issue of whether performance in this case is impossible in the given situation is contentious. Unfortunately, from the bulk of case law examined it would appear that whilst a price increase well beyond the normal range could constitute frustration in other jurisdictions, although increase in costs alone would not excuse performance[4] , this is rarely found in English law; where it is understood that a wholly abnormal rise or fall in prices would not affect the bargain.
The judgement in Tennants v Wilson[5] was that “the argument that a man can be excused from performance of his contract when it becomes commercially impossible seems to me a dangerous contention which ought not to be admitted unless the parties have plainly contracted to that effect”
In view of what can be considered “impossible”, it is to be noted that this is not to be used interchangeably with “impracticable” as to do so would widen the scope of the doctrine as it would include “extreme and unforeseen difficulty, expense, injury, or loss… [to one of the parties]…and unforeseen shortages or shutdowns…”[6] which is not the case under English law.
Davies v Fareham is a case where the claimant (who was the contractor) entered in to an agreement with the local authority (defendant) to build 78 houses within 8 months for a certain price. The contract contained clauses to deal with delay in completion of work, subject to the surveyor being required in certain events to allow such additional time as he might deem reasonable. Both parties had contemplated the possibility of some delay due to labour shortage but no express provision was made to deal with this contingency.
Owing to an unexpected lag in the demobilisation of building labour after the war, adequate supplies - especially of skilled men - were not immediately available to the contractor so that the total duration of the job was 22 months instead of 8, resulting in an additional cost of £20,000 which they purported to recover on the basis of an unexpected delay due to neither party’s fault frustrating the contract in law, so the completion of the work was done under an implied contract containing an implied promise by the local authority to make the contractor reasonable recompense for the additional expenditure involved.
This was unsuccessful. The House of Lords unanimously held the contract was not frustrated and in coming to this decision they re-examined the doctrine. Viscount Simonds held that when dealing with cases of frustration the courts should not feel obliged to imply terms into the contract; he stated “I do not propose to revive the controversy about the juridical basis of the doctrine of frustration. If it rests on an implied term of the contract to the effect that the parties will not be bound if a certain event happens, or does not happen, I can see no ground for saying that such a term must be implied in this contract. If it is permissible to judge by the event, it is clear that the parties would not have agreed on any such term. I pause to observe that it is not enough to say that, in the event of something unexpected happening, some term must be implied;”
Viscount Simonds went on to state that “the true doctrine rests not on an implied term of the contract between the parties but on the impact of the law on a situation in which an unexpected event would make it unjust to hold parties to their bargain; I would emphasise that, in this aspect, the doctrine has been, and must be, kept within very narrow limits.”
This principle is still relevant and followed in more recent cases such as The “Mary Nour”[7] and The “ Sea Ange”l[8].
The first case concerned an appeal made on behalf of the sellers of a cargo of cement (“Transclear”) seeking to overturn an order varying an arbitration award given against the buyers of the cargo (“CTI”) for damages for non-delivery of a cargo of cement; they were unable to provide the cement due to the operation of a cartel in that area, which was beyond their control but, nonetheless, not held to equate to a frustrating event as it was the “supplier’s decision to succumb to pressure from Cemex” (the cartel organisation’s name).
In light of the above analysis, it is likely that any attempts at arguing frustration as a result of the current financial crisis and its effect on trade or hire rates, will likely prove unsuccessful absent something specific in the contract to assist the party looking to rely on the doctrine of frustration. That said, the risk of losing the contract altogether and being left with nothing more than a claim in bankruptcy proceedings is a strong incentive for the other party to negotiate terms and a commercial approach in the current economic climate may prove effective.
[1] Taylor v Caldwell [1863] 3 B & S 826
[2] Krell v Henry [1903] 2 KB 740
[3] British Movietonews Ltd v London and District Cinemas [1952] A.C. 166
[4] Uniform Commercial Code s.2-615 (U.S. legislation)
[5] Tennants (Lancashire) Ltd v C.S. Wilson & Co Ltd [1971] A.C. 495
[6] Davies Contractors ltd v Fareham Urban DC [1956] A.C. 696
[7] CTI Group Inc v Transclear S.A. [2008] EWHC Civ 856
[8] Edwinton Commercial Corporation and Another v Tsavliris Russ (Worldwide Salvage & Towage) Ltd [2007] EWCA Civ 547
